Understanding the Psychology of Money
For Episode 1 of the Nova Money Mindset Podcast, Sam is joined by Dennis, an ex trader, and investment manager, one who is very familiar with the mathematics and behavioral aspects of finance. Dennis left the adrenaline of the trading floors to start his own company Cambridge Money Coach so he could focus on his true passion: educating people on their own psychology to transform the way they think about money.
The most overlooked fact in personal finance
When we think about personal finance, emotions don’t usually come into the picture but it’s something that plays a major role and Dennis spends most of his time coaching people on understanding how they think, feel and behave around money so that his clients can make better decisions, reduce anxiety and other negative emotions as well as communicate in healthy ways.
The psychological aspect of money is often overlooked. We tend to forget that managing money is also about managing your emotions, controlling your behaviors, habits, and how you will react to your environment.
So why is the psychological aspect overlooked? One reason might be due to the discussions around financial literacy. Topics like what does 100% APR mean and other numerical-focused questions to explain behaviour suggest that personal finance is all about the numbers. The conclusion from the podcast episode is that this is false. We’re not rational human beings. We have suboptimal biases which are cognitive shortcuts. What’s missing is realising what role our emotions play in our lives when it comes to personal finance.
Understanding the psychology of money
Understanding the emotional components that make up money is the same as understanding that dieting isn’t just about numbers, calories in and calories out, at least not from an individual perspective. There is a persistent stigma which says that if you’re not good at managing your money, then it means you must not be good with numbers.
Most people have never been shown how to manage their finances and the problem with that is money management skills is critical in today’s world. Most people don’t know how to use a chainsaw or how to fly a hot air balloon but that doesn’t really impact you on a day to day basis, not getting on top of your finances does.
If this post is making you feel like something is wrong with you, there’s nothing wrong with you. It’s just that nobody showed you. Take a 15 year old child and ask yourself how much of where that child is, what that child thinks or does is a result of the decisions made by that child. Dennis says not very much. The DNA lottery tells you where you’re born, what color you are, where your parents live and it’s very important because it’ll dictate what values you were brought up with, what school you went to, what your learning process was like, how you think about yourself, how you think about other people etc, all those things are massively important in life, yet none of them you were in control of. Move forward 10 years, actually all of those formative impressions, and beliefs have dictated what you’ve done for the next 10 years. That is why Dennis said we should start with self compassion because if we don’t, it would be hard to move on. ‘ On one hand, we are the result of our environment, so it’s not necessarily our fault if we don’t know things.’
We didn’t make most of the choices that make us who we are, but we can make choices about who we want to. We can choose who we want it to be.
Choosing who we want it to be is not an easy task. Unfortunately, nobody taught us how to do that. Dennis thinks the reason it’s not easy is because the default behavior is acting as the victim of, or succumbing to the social pressure or the advertisements.
The power of ads
Advertising is everywhere. Sam mentioned that there’s not a single day where he can open his emails without seeing adverts. And his working memory is then telling him this implicit message that he needs to become that guy on a rational level. Seeing the same thing over and over can make you want what is advertised and the long-term effect is that it becomes easy to forget who you want to be.
Start with forgiveness and self-compassion, because it’s really hard to believe you can make good choices. If you blame yourself for everything that you’ve done so far in life, without understanding what got you there in the first place, you may end up setting yourself up for failure.
How can you change your spending behaviour ?
Willpower? Dennis explained why it’s massively overrated. ‘It’s a really, really bad way to try and change things,’ he said. You need to change your environment so that it supports the decisions you want to make. And part of that is changing your internal environment, not just your external environment.
One reason why some people spend a lot is because of a developed financial response to use money to deal with the discomfort in our lives. This isn’t sustainable. So the way Dennis looks at money is about understanding that there’s three parts to it. The three parts include :
1.What you think about money.
2.What you think about yourself.
3.What you think about money and you.
So what does that mean? It means if you feel good about yourself, you have confidence in your knowledge and decision-making process. You take ownership of your outcomes. You feel good about money and can see that money is a tool to achieve wellbeing. It’s not the work of the devil, the root of all evil that most people tell you to believe. Money doesn’t make you feel anxious, regretful, ashamed, or guilty and you can see yourself as someone who manages their finances well. Our relationship with money is also about how we feel about ourselves as much as how we interact with money and how we feel about money.
Have you identified a pattern where you would be more susceptible to buying things that you don’t need? Just because you’re trying to feed a certain type of emotion? We all have and it shows us how important emotions are when it comes to our spending habits.
HALT before you make a bad decision.
The easy-to-remember mnemonic HALT tells us that we can easily make really bad decisions when we’re hungry, angry, or anxious, lonely or tired. So if you look at people who are on Amazon at three o’clock in the morning, that’s not great. You’re anxious, you’re angry, you’re lonely or tired. If you’re hungry or tired, there isn’t enough energy in the system to run conscious cognitive processing. How much energy you have depends on how the brain allocates energy to the various processes of running the body, doing exercise and managing those metabolic processes is actually quite important. So when you’re tired, you can’t concentrate because the brain says you’ve not covered too much energy.
If you spend a lot of time in pain around your finances, your brain thinks finances are painful and releases cortisol, that means it narrows your capacity to think. And guess what? That just perpetuates a situation. Every time you think about your finances, you feel awful…
Technology is making us weak.
20,000 years ago, we were hunter gatherers. We were foragers. We were wandering around in groups of 50 to 150 people. (not trying to make it sound romantic cause it wasn’t.)
Technology has made us become so dependent on instant gratification. And that’s why in the end, it’s so hard to manage money because weak people don’t have the tendencies to think long-term to do what’s right today, and to have delayed gratification.
Money and spending is all about resource management. And to them, our problem is that we have an overabundance of things to buy and to eat.And our problem is to control ourselves, because our brain was designed to survive in the world of scarcity.
Another reason why the topic of emotions and money is rarely discussed which Dennis pointed out was because we get laughed at for expressing emotion. And that message gets reinforced through school and, and by the rest of society. And it’s really damaging. Emotions are really important. We started with the concept that you can’t make good decisions without emotions. So what are we doing with our emotions by pretending they don’t exist or trying to be nice, then tie them with drugs, spending ; dopamine, with risky activity and risky behavior.
We don’t often say it, but spending money can become an addiction and if you feel like this is happening to you, then start with self-compassion.
Check out the full podcast episode here!